Unemployment can be added wrinkle at tax time

Leaving a job, whether you got laid off, fired or took a buyout package, can definitely bring about some twist and turns when filing a tax return. When filing a tax return, job loss is not a one-size-fits-all category.

Some who received a hefty severance or voluntary buyout package could end up in a higher tax bracket and owing taxes. Conversely, taxpayers whose income took a big hit may now qualify for tax breaks.

Surprising to many, unemployment benefits are considered taxable income. The feds began taxing unemployment payments starting in 1979. But for tax year 2009, the first $2,400 of unemployment payments are not taxable at the federal level due to stimulus legislation passed last year.

Those who received unemployment benefits should receive a form 1099-G prior to Jan. 31, showing the amount of taxable unemployment benefits paid in the prior year. Taxpayers should also aware they could get hit with penalty taxes when making early withdrawals from retirement accounts.

"You can get a serious penalty (from taking early withdrawals) out of a 401(k) or an IRA," said Michele Day, a certified public accountant. "There are exceptions, but you have to check to see what they are."

And while there are federal income tax breaks for job search and moving expenses related to finding a new job, restrictions apply.

Taxpayers who itemize can deduct job-hunting expenses under the category of miscellaneous itemized deductions.

Severance and voluntary buyout packages, which are treated as earned income, are subject to state and federal income taxes along with Medicare and Social Security taxes. Lump-sum severance and voluntary buyout payments have income tax taken out at a flat-rate, generally 25 percent at the federal level and 6 percent at the state level.

If you were laid off and got a big severance package, your income level could go up as could your tax bracket. The same scenario could happen if you took a voluntary buyout package.

"If they get a sizable severance buyout, they could be under withheld," said Robert Caplan, a Foster City, Calif., certified public accountant.

A sizeable payout can also affect qualified retirement plans. For example, a married couple filing jointly covered by a workplace retirement plan can have adjusted gross income in 2009 of no more than $109,000 to qualify for a tax deduction on a traditional individual retirement account. The deduction phases out starting at $89,000.

On the other hand, "you may have the ability to put money into an IRA you could not have otherwise," said Caplan. "But not everyone has the money to (contribute) if they are unemployed."

People who have seen a steep drop in income should be aware of the little-known Savers Credit, said Mark Steber, chief tax officer at Jackson Hewitt Tax Service, a tax preparation firm. It's a federal income tax break that rewards low- and moderate- income taxpayers for contributing to an IRA, 401(k) or other qualified retirement plan. "That's probably the number one overlooked (tax break) and it's not just for the unemployed," Steber said. "It's a great benefit."

To qualify, adjusted gross income cannot exceed $55,500 for married couples filing a joint return and $27,750 for single filers in 2009. It allows for a credit up to half of the first $2,000 contributed annually to a retirement plan. It also can be used in conjunction with other tax breaks such as claiming an IRA deduction. However, distributions taken from retirement plans are subtracted from contributions when figuring the credit.

Another overlooked tax break is the Earned Income Tax Credit, which provides a federal tax credit for low- and moderate-income taxpayers who worked either all or part of the year. The stimulus plan significantly increased the EITC and qualifying income limits to reach more people during tough economic times. Under the new amount, the income cap for a married couple filing jointly with three or more children was raised to $48,279 in 2009.

TAX TIPS FOR THE UNEMPLOYED:

- Withdrawals from your pension plan are taxable unless they are transferred to a qualified plan, such as an IRA. If you are less than 59 { years old, an additional tax may apply to the taxable portion of your pension.

- If you withdraw retirement funds before you reach eligible age and do not roll it over into another qualified retirement plan or IRA within 60 days, that amount will be taxable income in the year in which it is withdrawn. You may also have to pay an additional 10 percent penalty tax on those early distributions. Eligible age is 59 { years for traditional IRA distributions, but there are exceptions for hardships and other life events.

- You can avoid a penalty tax on 401(k) and IRA early withdrawals by establishing a payment schedule of regular equal withdrawals over your lifetime or the joint lives of you and your beneficiary. There's also no penalty if you take a distribution from your 401(k) when you separate from service at age 55 or older.

For more information, check out IRS Publication 4128, Tax Impact of Job Loss available at www.irs.gov or by calling 1-800-829-3676.

Source: Internal Revenue Service, California Society of Certified Public Accounts

TAX CREDITS TO WATCH:

Here are some other tax breaks to consider that are tied to income levels, regardless of employment status:

- Child Tax Credit provides a tax break of $1,000 per qualifying child. Starts to phase out when adjusted gross income exceeds $110,000 for joint filers and $75,000 for single filers.

- Childcare Tax Credit amounts to 35 percent of qualifying child-care expenses for taxpayers with incomes of up to $15,000. Credit amount then decreases with income to 20 percent of allowable expenses for income of $43,000 and above.

- The American Opportunity Credit has been increased to help pay for college expenses to reach more taxpayers. Many of those eligible will qualify for the maximum annual credit of up to $2,500 per student, $1,000 of which is a refundable credit. A refundable credit means you can get a refund provided the refund exceeds taxes owed.

(c) 2010, Contra Costa Times (Walnut Creek, Calif.).

Distributed by McClatchy-Tribune Information Services.